Macro Weekly – Disappointments and pleasant surprises in the eurozone in 2014

by: Han de Jong

Macro Weekly 19 December 2014 ()

The economy of the eurozone has disappointed this year. That is certainly the perception in the markets and the media, and it is hard to disagree. It is useful not only to look at the eurozone as a whole, but also to look at how individual countries have performed compared to expectations. In this last Big Picture of the year, I note that several eurozone economies have actually exceeded expectations in 2014. They are generally seen as the weaker, most vulnerable economies. The fact that they are doing better than expected is an extremely well-kept secret and, obviously, good news. My conclusion is that the policies these countries have implemented in recent years are successful. Others should follow. Several other countries have disappointed and Germany is probably the most unsuspected country in that group. Why did all of that happen and what are the key lessons we must draw? But before we look at that analysis, some brief comments about Russia are in order.

Dear readers,

This is our last Big Picture of 2014. Also on behalf of my colleagues, I want to thank you for your interest and your support. We wish you very nice holidays and a healthy and successful 2015.

Russia and oil

Financial markets have been preoccupied recently with the sharp decline in the price of oil and its implications. While cheaper oil is good for oil importers, the extent and speed of the price fall has put huge pressure on oil exporters, in particular Russia. How this will unfold is hard to say. Russia is set to experience a very unpleasant recession and risks of a financial crisis are significant. It is hard to know how Russian political leaders will respond to the increased pressure, which could lead to dangerous international political developments. Luckily, Russia has significant financial reserves, enabling them to weather at least the first storm. We believe that the oil price is currently overshooting on the downside. When markets stabilise, stress will be reduced, although the economic outlook for Russia’s economy during the period ahead is challenging, to say the least. If oil prices continue to drop, there is a risk that the nervousness and volatility this will create in relation to Russia will dominate the positive effects of increased spending power of oil importers.

The facts about the eurozone’s economic performance do not lie

In order to establish which eurozone countries have disappointed more than others, I have compared last year’s forecasts for GDP growth and for growth of domestic demand in 2014 with how things are now turning out. I am comparing the forecasts as they were published in the OECD Economic Outlook of November 2013 with the projections for 2014 as the OECD published them recently in their Economic Outlook in November 2014. I find the results interesting and they justify a number of conclusions.

141219 - domestic demand

141219 - GDP


US disappoints more than the eurozone

US GDP and domestic demand growth has been weaker this year than was expected a year ago. What is particularly remarkable is that the degree by which the US has undershot expectations is larger than is the case for the eurozone. In fact, domestic demand growth in the eurozone is now expected to be merely 0.2% weaker than expected a year ago. This is easily within the usual margin of error. I must admit that the reason for the relatively large disappointment in the US is the very weak first quarter when adverse weather took a heavy toll on economic activity. In addition, the recent OECD growth projections for 2014 are based on information available until the moment the projections were made. The US economy is obviously doing well at the moment and chances are that the actual outturn for 2014 will be a little better than the OECD was expecting in its recent Outlook.

Wide divergence within the eurozone

A second conclusion from the data is that there are big differences between individual eurozone countries. Some have disappointed, but others have exceeded expectations. That latter point is not something that is highlighted often. Finland and Austria are among the countries disappointing the most. I do not follow these economies in detail, but what they have in common is a relatively high exposure to economic trends in Eastern Europe, particularly Russia. That is very clear in the case of Austria, where export growth has been much weaker than was expected in the 2013 Outlook. Finland seems to have a bigger problem with domestic demand. Fiscal tightening, which was not foreseen last year, seems to have played a role.

A red rag to a bull

Arguably, the most striking finding in this data is that Ireland, Spain, the Netherlands, Greece and Portugal have all exceeded expectations this year. And by meaningful margins. Spanish domestic demand growth, for example, is now thought to have been 3% stronger than was expected a year ago. Ireland has done even better, but that is a small and relatively volatile economy. Domestic demand in Portugal has beaten expectations by 1.5%, which is also welcome. These positive surprises confirm trends that can be seen in other data series. Spanish unemployment currently stands at 23.7%. That is unacceptably high, but a good deal better than the 27% reached in early 2013. It is a message I have expressed in recent discussions. I have also added that perhaps we should not compare Spanish unemployment statistics with, for example, Dutch ones as far as the absolute level of unemployment is concerned. Before the euro started, the Spanish economy was growing at a decent clip. Yet, registered unemployment stood at over 15%. And just before the financial crisis broke in 2008 unemployment was over 8%. But that was at a time when Spain was running a deficit on the current account of its balance of payments of a staggering 10% GDP, a clear signal that the economy was totally overheating. Such remarks generally work like a red rag to a bull. Even people who are generally favourably disposed towards me tell me that such remarks are irresponsibly optimistic and completely ignore the economic and social pain that many people are suffering. I do not wish to be insensitive and I do not think I am. But we are where we are. The economic situation is bad. Everybody knows that. We need to look ahead. And the point is that improvement is happening and too many people are unwilling to see it. An old Chinese proverb says that even a journey of a thousand miles begins with a single step. I would assert that Spain has a long way to go, but the first couple of steps have been taken. The same is true for several other countries. My colleague Aline Schuiling showed in a recent analysis that a number of countries have risen on international lists of comparison, such as the World Bank’s ‘Ease of doing business’ and the Global Competitiveness Index of the World Economic Forum. These countries are broadly the same as the ones outperforming growth expectations this year. The conclusion is that the policy approach is working. Very few economists and commentators are willing to acknowledge that, but it can only be a matter of time before they open their eyes.

Germany, an unexpected disappointment

Most people focus on France and Italy when discussing the most problematic countries in the eurozone and I have a lot of sympathy for that view. These countries lack economic dynamism and should implement policies that will increase their growth potential. In my darker moments I fear that it will only happen if they hit a brick wall first. When I feel more upbeat I think that they will realise what needs to be done before disaster hits and that it can be argued that their governments have started the reform process, but that it needs to be looked at with patience.

What is perhaps the most surprising is that Germany has disappointed so much this year. Aline Schuiling has also looked at this issue some weeks ago. Our conclusion is that Germany’s relatively poor performance is due to temporary factors. Our conviction on this point has been strengthened recently by an improvement in cyclical indicators. The authoritative Ifo index of business confidence, for example is on the rise. Having fallen in six consecutive months following April, German business confidence rose convincingly in November and December. The more volatile ZEW index of analysts confidence has also turned. The expectations component of this survey rose strongly in December after a very solid rise in November. The improvement in these two months more than reversed the total drop in the index of the previous six months.

The implications of this comparison

My main take away is that things are not as bad as perceived by many. Yes economic growth in the eurozone as a whole has disappointed this year and challenges remain significant. Yet, several countries have beaten expectations. Germany’s poor performance is largely due to temporary factors and that economy is currently improving. But perhaps the most important conclusion is that the countries that have suffered the most are now doing well. There is still a long way to go, but the light at the end of the tunnel is getting bigger and brighter.

Greek politics are a concern

Greek politics continue to be a concern for financial markets. I wonder to what extent that is justified. Let me start by saying that I am not an expert on Greek politics. However, I recently had a long chat with a good Greek friend who I consider an expert. The Greek parliament failed to choose a new president in their first attempt last Wednesday. The second vote will be cast on 23 December when the president can only be elected if at least 200 out of 300 MPs back the government’s candidate, Mr. Stavros Dimas. No doubt the vote will fail again. In a third and final vote on 29 December ‘only’ 180 votes are required. It is possible that number will be achieved as independent deputies and deputies belonging to other parties may support Mr Dimas in exchange for particular political concessions. If the third vote fails again, general elections must be held. Many deputies are set to lose their seat in new elections and this risk may trigger them to support the government’s presidential candidate in the third vote. Markets will probably be relieved should Mr Dimas be elected. But what happens if he isn’t?

Who is afraid of Syriza?

The good thing about Greek politics is that elections can be called at short notice and that forming a government is a quick process (unless it fails). According to opinion polls, Syriza is set to win new elections, although New Democracy of prime minister Samaras is not very far behind. Pasok, the old powerhouse of Greek politics, hardly features. My Greek friend referred to Syriza as a ‘centre left party’. That surprised me as my perception was that they are left-wing radicals. Wikipedia makes a reference to Maoists and Trotskyists in relation to Syriza, not exactly something that encourages confidence among financial markets participants. But my friend explained to me that many new members and supporters of Syriza are very moderate and that its leader, Alexis Tsipras has clearly moved towards the middle of the political arena in recent months. He, allegedly, is a believer in a market economy, though with a social focus, and does not want to take Greece out of the euro. So my friend suggested that financial market fears for a Syriza-led government are probably exaggerated. In addition, Syriza is unlikely to win an overall majority. The communists are ruling out forming a government with Syriza, leaving a grand coalition of Syriza and New Democracy as the most likely ultimate outcome.

The bottom line is that the situation is unpredictable and can be volatile, but that things will most likely not be too bad when all the dust settles.